The action of the Federal Reserve Open Market Committee in its July meeting was along expected lines, with the committee hiking the Fed funds rate by 25 basis points and resolving to continue reducing its balance sheet. There was little alteration in the FOMC statement since the June policy; the Fed continues to maintain that price stability is its top priority, with future policy actions depending on incoming data.
But the tone of the post-policy press conference was positive with the Federal Reserve Chairman acknowledging that consumption and labour market conditions are encouraging. He also stated that the Federal Reserve staff are now projecting a notable slowdown in growth, but no longer forecasting a recession. Fears about the Fed’s restrictive monetary policy impacting growth in the US have been somewhat assuaged in this meeting. This is good news for India since the US is among our top partners for both goods and services exports. Besides this, there are strong indications that the rate hike cycle in the US could be coming to an end
The summary of economic projections of Federal Reserve Board members in June 2023 indicated the peak of the current policy rate hike cycle could be at 5.6 per cent in 2023. The policy rate has moved quite close to this level. Inflation in the US as measured by the PCE (personal consumption expenditure) index has been steadily declining from 6.8 per cent last July to 3.8 per cent this July, providing some degree of comfort to the Fed. Though inflation is still far above the long-term target of 2 per cent, the Fed would like to wait for the full impact of its 525 basis points rate hikes made since early last year, to manifest itself.
As the Fed Chairman said, the effects of the policy tightening are being felt on demand in the most interest-rate-sensitive sectors of the economy, particularly housing and investment. It may not want to jeopardise growth too much. Of interest is the fact that the projections show the possibility of a 100 basis points decline in the policy rate in 2024.
The rupee and India’s external sector will get some relief due to the expectation of a reversal in the US Fed’s monetary policy stance. The US dollar index has weakened considerably since last September, declining from 112 to 100 now. A weaker dollar removes pressure on the rupee and also boosts foreign portfolio inflows, which have already improved this fiscal year. The pressure on the RBI to maintain the spread between the US and Indian sovereign bond yields will also lessen as the US rate hike cycle tapers. With the CPI inflation in India not too worrisome, the RBI can also adopt a wait and watch policy for now.
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